Signs of the Time. The Tipping of the American Economy.FinancePerspective on the News
Monday, October 11, 2010Ed DeShields

Little changes can have big effects. When small numbers of people start behaving differently, that behavior can ripple outward until a critical mass or tipping point is reached, changing the world.

Case in point; five of seven of the Fed’s Board of Governors have favored turning on the printing presses and using this money to buy financial paper in a effort to stimulate the econmony and force a deflation of the dollar.

They hope to reflate the U.S. economy. If they can make mortgages cheaper, demand will help keep home prices stable. If they can get a rally going in the stock market, the "wealth effect" will cause consumers to think they’re ready to start spending. If they can push down interest rates on cash, people and companies will save less and spend or invest more. Just like the good old days.

That’s a lot of “ifs”. No one knows whether it will actually work.

Some consider this move by the Fed as the biggest economic gamble in history. It has never be tried before and the list of unintended consequences could be worse than the medicine itself – like a decades-long economic Depression and rising prices.

Just the hint of their theory has caused commodity prices to soar. The recent oil price hikes alone are estimated to suck another $450 out of our pockets in the next twelve months. Rising prices are a direct tax on consumers.

How many trillions will have to be printed for it to work – $5, $6 trillion as one economist predicts? Can we pay it back? If interest rates rise, at what point does our interest bill consume the rest of our national income?

The back story here is that our interest rates are effectively at zero. The government has little control over the economy. In normal times, the Fed can reduce interest rates to stimulate demand from consumers. Despite zero interest rates the consumer is not spending and since most of the economy is based on consumer spending we’re in big trouble.

Can they fool us into spending?

What money we are spending is on foreign goods. Our trade deficit saps the economy as our wealth flows out of the country. The Fed’s secret weapon includes a deflating dollar so that our exports become more expensive to other countries and makes the economy grow faster. So by turning on the printing presses to buy long term bonds and treasuries, the dollar falls.

Unfortunately, what’s good for the goose, is also good for the gander.

In response to a less cautious U.S. Fed, the developed world's central banks are moving—at varying speeds and intensity—to respond to a weak recovery, reduce the risks of a global deflation and restrain their currencies from rising against those of their trading partners. A currency war has begun. He who devalues their currency wins the export war.

On Tuesday, it was the Bank of Japan's turn. Japan has been anticipating that the U.S. Federal Reserve will resume large-scale purchases of U.S. Treasury bonds. Japan’s economy has been in the duldrums for over ten years. In order to spur growth and restrain a rising yen, the Japanese central bank launched a bond-buying program itself.

Now central bankers elsewhere are strongly indicating that they are preparing to open credit spigots to reflate their economies at a time when fiscal policy is stalled or contracting. Nearly every major economy is now looking to restrain the rise in or push down its currency to give its exports some buying power.

Unfortunately, we don’t have a currency problem. We have a consumer with no money who isn’t buying problem.

It is doubtful that the Fed’s new strategy will be enough to really do anything in the way of reflating assets. And, it will be not be good for the dollar. A falling dollar will be at the direct expense of other countries who are also fighting to recover from the Great Recession. This is what starts wars. Physical wars.

If the Fed does it, it gets legitimized everywhere which means the race has begun. Do we really want to fire the first shot in a race to the currency bottom? Are we that desperate that our government is willing to risk it all?

It had better work or we’ve just evaporated our children’s quality of life.